MNP rapport 500035003 Caps and Fences in Climate Change ... - PBL

Report 500035003/2005 Caps and Fences in Climate Change Policies Trade-offs in shaping post-Kyoto JC Bollen*, AJG Manders*, PJJ Veenendaal**

This report contains an erratum d.d. 09/08/2005 on the last page

*

Netherlands Environmental Assessment Agency (MNP associated with the RIVM), PO Box 303, 3720 AH Bilthoven, The Netherlands, email: [email protected]; Telephone : 31 - 30 - 274 3610; Fax: 31 - 30 - 2744464; website: www.mnp.nl ** Netherlands Bureau for Economic Policy Analysis (CPB), P.O. Box 80510, 2508 GM The Hague, The Netherlands.

This investigation was performed with the support of the Dutch Ministry of Housing, Spatial Planning and the Environment as part of the National Climate Change Project M/500035.

Netherlands Environmental Assessment Agency (MNP associated with the RIVM), PO Box 303, 3720 AH Bilthoven, The Netherlands, Telephone : 31 - 30 - 274 27 45; website: www.mnp.nl

Netherlands Environmental Assessment Agency

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Abstract Caps and Fences in Climate Change Policies, Trade-offs in shaping post-Kyoto The Kyoto Protocol represents an initial, small step towards mitigating global warming. Much larger greenhouse gas (GHG) emission reductions will be necessary in the post-Kyotoera to stabilize atmospheric GHG-concentration levels at a ‘safe’ level. The more ambitious reduction targets that need to be set and the desirability of getting more countries involved makes the establishment of follow-up commitments beyond 2012 a challenging task. Our paper can be viewed as a sequel to a report (Bollen, Manders, Veenendaal, 2004) documenting the assessment of impacts of a policy scenario in which industrialized countries in 2020 accept emission targets that are 30% below 1990 emission levels. Our aim in this paper is to provide an analysis of additional scenarios over and above this case. In this way, policy makers will be provided with a broader spectrum of alternative post-Kyoto policy scenarios and their implications. The analyses of the macro-economic consequences of post-Kyoto policies in 2020 reveal the costs of climate policy to be largely determined by three factors: the reduction target, the economic development in the underlying scenario without new climate policies, and the design of policy. The studied policy options in the report are coalitions with (much) less than global coverage, restrictions on emissions trading, full versus limited use of the Clean Development Mechanism (CDM) and, finally, less ambitious aims, achieved by raising caps or imposing fixed (relatively small) carbon taxes. Alternative tradeoffs between abatement costs and abatement efforts are established and discussed in this context. We show the abatement costs in the benchmark case of a global coalition and unrestricted trade to be relatively modest and conclude that these costs could rise considerably with smaller coalitions. A smaller coalition will induce migration of energy-intensive activities to nonparticipating countries. CDM may lower abatement costs in incomplete coalitions. Seizing CDM opportunities will reduce emissions only in part due to domestic leakage in the developing countries. Though carbon tax systems may be as effective in reducing emissions as cap-and-trade systems the compliance costs for countries will be quite different. Key words: Post-2012 climate policies, CDM, cost-effectiveness


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Korte samenvatting Doelstellingen van het klimaatbeleid en beperkingen aan emissiehandel, dilemma’s in de vormgeving van post-Kyoto beleid Het Kyoto Protocol is een kleine eerste stap naar het stabiliseren van broeikasgassen in de atmosfeer. Na de eerste budgetperiode (2008-2012) van het Kyoto protocol zal de uitstoot van broeikasgassen in toenemende mate beperkt moeten worden om dit te bewerkstelligen. De keuze voor ambitieuzere doelstellingen vergt een toetreding van landen die nu nog geen doelstelling op zich hebben genomen. Dit rapport is een vervolg op van het rapport dat gepresenteerd is op de klimaatdag (30 juni 2004) over de gevolgen van een beperking van 30 procent van de uitworp van broeikasgassen in 2020 ten opzichte van het niveau in 1990. Het doel van dit rapport is een overzicht te geven van additionele analyses, ten einde beleidsmakers te informeren over de gevolgen van alternatieve post-Kyoto varianten. Dit rapport analyseert the macro-economische gevolgen van post-Kyoto beleid voor het jaar 2020. De kosten van het beleid worden bepaald door drie factoren: het niveau van de doelstelling, de economische ontwikkeling van het basispad zonder dat er klimaatbeleid wordt gevoerd, en de vormgeving van het beleid. De beleidsalternatieven die onderzocht zijn omvatten coalities die niet alle maar een beperkt aantal landen bevatten, of beperkingen stellen aan de handel in emissierechten, vrije of beperkte toepassing van het Clean Development Mechanism (CDM), en tot slot varianten met minder ambitieuze doelstelling voor niet-mondiale coalities. De kosten van klimaatbeleid verminderen de economische groei. Deze notitie gaat in op de uitruil tussen economische groei en de beleidsinspanning. De kosten zijn beperkt in een mondiale coalitie met vrije emissiehandel. Maar deze kosten stijgen sterk met kleinere coalities en beperkingen op de emissiemarkt of van de toepassing van CDM. Ook treedt er bij niet-mondiale coalities verplaatsing op van energie-intensieve industrieën naar de landen die geen klimaatbeleid hoeven te voeren. CDM kan de kosten van het klimaatbeleid voor de geïndustrialiseerde wereld aanzienlijk verlagen, maar tegelijkertijd treden er onvoorziene weglekeffecten op van het beleid in de landen waar de CDM projecten worden uitgevoerd. Uniforme koolstofheffingen zijn even effectief als emissiehandel, maar de verdeling van de lasten zijn wel verschillend. Steekwoorden: post-2012 klimaatbeleid, CDM, kosteneffectiviteit


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Preface The Kyoto Protocol represents an initial, small step towards mitigating global warming. In the post-Kyoto era much larger greenhouse gas (GHG) emission reductions will be necessary to keep atmospheric GHG-concentration levels at a ‘safe’ level. Due to the more ambitious reduction targets that need to be set and the desirability of getting more countries involved, establishing a follow-up treaty to the Kyoto Protocol will be a challenging task. This study can be viewed as a sequel to a previous study that assessed the impacts of a policy scenario, in which industrialized countries in 2020 accept emission targets that are 30% below 1990 emission levels. The aim of this study is to provide an analysis of additional scenarios over and above the previous one, thus providing policy makers with a wider spectrum of alternative post-Kyoto policy variants and their respective implications. This study was carried out jointly by the Netherlands Environmental Assessment Agency (MNP) and the Netherlands Bureau for Economic Policy Analysis (CPB) at the request of the Dutch Ministries of Housing, Spatial Planning and the Environment (Minvrom) and Economic Affairs (Minez). The authors, Johannes Bollen, Ton Manders (both MNP) and Paul Veenendaal (CPB), gratefully acknowledge the useful suggestions and comments from colleagues and the members of the feedback group. Specifically, they wish to thank Erik Schmersal, Ronal Flipphi (Minvrom), and Klaas-Jan Koops (Minez).

N.D. van Egmond, Director Netherlands Environmental Assessment Agency (MNP) F.J.H. Don, Director, Netherlands Bureau for Economic Policy Analysis (CPB)


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Contents Summary

6

1

Introduction

13

2

Post-Kyoto policy scenarios

15

3

A benchmark case: - 30% reduction for Annex I within a global coalition

19

4

Trade-offs: costs, coalitions and the environment

21

5

Macro-economic consequences for EU-25, the Netherlands, and non-Annex I 23

6

Impacts on energy use in the Netherlands

27

7

CDM and leakage in non-member countries

29

8

Conclusions

33

References

35

Appendix Tables

37


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Summary In the post-Kyoto era much larger greenhouse gas (GHG) emission reductions will be necessary to stabilize atmospheric GHG-concentration levels at a ‘safe’ level than the reductions that have been agreed on under the Kyoto Protocol. Due to the more ambitious reduction targets that need to be set and the desirability of getting more countries involved, establishing follow-up commitments will be a challenging task. In departing from the central scenario of a 30% emission reduction by the Annex I countries in 2020 compared to the 1990 levels (see Bollen, Manders and Veenendaal, 2004), this study modestly aims to provide an analysis of additional scenarios over and above this case. In this way policy makers will be provided with a wider spectrum of alternative post-Kyoto policy settings and their implications. In particular, impacts will be assessed pertained to varying coalition size, restrictions on imports of emission permits, and utilization of the Clean Development Mechanism (CDM) and of other, often more limited emission reduction targets, as implied by raising emission caps or imposing carbon taxes of limited height. The assessments are made in terms of policy-induced deviations in 2020 from a baseline that does not contain any post-Kyoto climate change policy. This baseline is a global scenario characterized by relatively high growth rates, called GLOBAL ECONOMY which has been adapted for the Netherlands to reflect the most recent views of the so-called Reference Projection on Dutch developments within the context of this scenario. The consequences of choosing this baseline are twofold. On the one hand, the costs of complying with the policy targets will — because of its relatively high rates of economic growth — be relatively high. On the other hand, the adaptation of Dutch baseline assumptions to the projections contained in the Reference Projection has made the emissions profile for the Netherlands much more modest than the previous one. Hence, our assessment of Dutch compliance costs for the central case becomes more modest too. Whereas Bollen, Manders and Veenendaal (2004) assessed Dutch compliance costs for the central case (0.8% of real national income) to be relatively high within the EU context, this study points to macro-economic costs for the Netherlands that are more or less average (0.5% of real national income). Unsurprisingly, the study shows that shrinking coalition size —while maintaining reduction targets for its members— raises abatement costs and may reduce environmental effectiveness. In particular, if EU-25 travelled the post-Kyoto road alone, the macroeconomic costs to the Netherlands would amount to 2.3% of national income in 2020, while global emissions would rise 20% above those of the central case. If imports of emission permits were to be restricted by requiring that half of the abatement should be achieved domestically, costs could rise in the regions where this restriction becomes binding and fall elsewhere due to depressed import demands. As the Netherlands


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rely heavily on foreign abatement to meet their climate change target, Dutch compliance costs will rise (with 0.4% in addition to the 0.5% compliance costs of the central case). Opening CDM opportunities in non-member countries for an Annex I coalition reduces compliance costs on the one hand, but tends to raise global emissions on the other. This is caused by leakage in the host countries. For example, if CDM is applied to power plants, local electricity prices are likely to decrease. As project funding is at marginal costs, electricity suppliers will make infra-marginal profits. Because of competition these will, in the end, be passed on to consumers in the form of lower prices. Hence, electricity demand will rise and emissions will increase again. Moreover, if the supply of primary energy carriers such as coal is inelastic, the price decrease due to the CDM projects will trigger additional demands in other sectors of the economy. Taking these impacts jointly, local leakage may amount up to 40% of the direct reductions targeted via the CDM project. However, if CDM projects are also allowed to taker place in other sectors (such as the energy-intensive sectors) leakage may diminish considerably, with substantial cost savings to Annex I. Less ambitious targets lead to lower costs and higher emissions. For example, compliance costs for a coalition of Annex I countries with a reduction target of 30% would amount to 2% of real national income. If this reduction target were to be halved, global emissions would rise by 6% in 2020 and compliance costs for Annex I would fall by 0.8% of real national income. If the Kyoto targets were to be extended to 2020, and the United States and Australia were to join with ceilings at their 2010 baseline emission level, compliance costs for the current Kyoto partners would actually fall due to new abatement opportunities within the United States. Global emissions in 2020 would rise substantially, however, by more than 25% compared to a 30% reduction for an Annex I coalition. The impacts of substituting cap-and-trade schemes for uniform carbon taxation are dependent on the divergence between the level of the emission price and that of the carbon tax. Where coalitions are identical, a lower tax rate will reduce costs and increase emissions, while the opposite is true if the tax rate exceeds the price of tradable permits. Ignoring income effects, both schemes would be equally efficient in abating global warming if the time profiles of permit prices and carbon taxes coincided. The distributional impacts may be substantial though. If, e.g., a global cap-and-trade scheme with a permit allocation approximating equal rights per capita is replaced by a global carbon tax, compliance costs will diminish for Annex I countries but become substantial for developing countries. Though the revenues from carbon taxation may be partly used for international income transfers that would make the burden-sharing acceptable to negotiators, domestic pressure to recycle these revenues back into the own economy is likely to prevent such an agreement being concluded.


1.

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Introduction

The Kyoto Protocol represents an initial, small step towards mitigating global warming. In the post-Kyoto era much larger greenhouse gas (GHG) emission reductions will be necessary to keep atmospheric GHG-concentration levels at a ‘safe’ level. The point of departure of our study is the aim to bring emissions of industrialized regions in 2020 down by 30% below 1990 emission levels. This aim can be shown to be compatible with the EU ambition to limit the rise of global mean temperature to 2° Celsius above pre-industrial levels. Bollen, Manders and Veenendaal (2004) showed the macro-economic consequences of emission reductions in Annex I countries of 30% in 2020, compared to 1990 levels, against alternative background scenarios of economic growth. This report can be considered as a sequel to the Bollen, Manders and Veenendaal (2004), again taking a 30% emission reduction in Annex I countries in 2020 as a point of departure, and showing the consequences of additional, alternative post-Kyoto policy variants1. In particular, we will show the impacts of varying coalition size, restrictions on imports of emission permits, and the utilization of the Clean Development Mechanism (CDM) and of other, often more limited emission reduction targets (less than 30%), either by raising emission caps or by installing a carbon tax of limited height. These findings will provide policy makers with a wider spectrum of alternative postKyoto policy options and their implications. In the first section we will first explain the set-up of the scenarios in more detail and in the second, the approach followed. In section 3 we present the benchmark case of 30% emission reduction by Annex I countries in 2020. Detailed tables of simulation outcomes for each of the scenarios are to be found in the Appendix. Rather than commenting exhaustively on the impacts of each policy scenario in sequence, we will focus on certain impacts. In section 4 we will discuss the trade-offs pertaining to costs, coalition size and emissions, and in section 5 focus on the macro-economic consequences in terms of changes in real national income. The impacts on Dutch energy consumption and its’ composition from different sources will be discussed in section 6. Opportunities to earn credits through CDM will lower compliance costs for the Annex I countries. However, CDM may be rather ineffective from the environmental point of view because of local leakage in non-Annex I countries. Section 7 provides an analysis of the compliance costs and leakages occurring in these policy variants. The final section 8 concludes.

1

Post-Kyoto policy variants concern policies and targets beyond 2012 and are analyzed for the year 2020. This does not necessarily imply an

end of the Kyoto Protocol, but could also constitute an addition to the Kyoto Protocol.


2.

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Post-Kyoto policy scenarios

In this study we assess a large number of policy variants. Table 2.1 gives an overview of all simulations considered. Table 2.1

Policy properties

Coalition

Emissions cap for industrialized countries -30%

-15%

Kyoto forever

Uniform carbon tax -30%, Imports =